Evening Update

Economic Reports Lift Stocks

Stocks finished with small gains after some encouraging economic data, most notably a much better-than-expected retail sales report that showed surprising strength in consumer spending during August. Other reports showed a subdued inflation reading, an increase in manufacturing activity in the New York region, and another drop in business inventories. Treasuries finished lower following the data. Gains in equity markets were limited though, after disappointing earnings from Best Buy and Kroger, and monthly credit card data from many of the nation’s largest banks showed that loan losses continued to mount in August. Elsewhere, Citigroup was reported to be discussing a way for the government to dispose of its 34% stake in the company, and Illinois Tool Works improved its 3Q outlook, while a speech from Fed Chairman Ben Bernanke attracted attention after he announced that the recession is “very likely over” although unemployment will be stubbornly high for some time and the economic recovery is likely to be “moderate” instead of rapid.

The Dow Jones Industrial Average was up 57 points (0.6%) to close at 9,683, the S&P 500 Index increased 3 points (0.3%) to finish at 1,053, and the Nasdaq Composite advanced 11 points (0.5%) to 2,103. In moderate volume, 1.5 billion shares were traded on the NYSE and 2.4 billion shares were traded on the Nasdaq. Crude oil climbed $2.07 to $70.93 per barrel, while wholesale gasoline was up $0.05 at $1.79 per gallon, and the Bloomberg gold spot price added $7.15 to $1,007.35 per ounce.

Consumer electronics retailer Best Buy (BBY $38) was solidly lower after it reported 2Q EPS of $0.37, which missed the $0.42 Wall Street estimate, but revenues rose 12% versus last year to $11 billion, topping the $10.8 billion revenue forecast of analysts. The company said its revenue gains—which reflected the inclusion of Best Buy Europe’s revenue—were partially offset by a same-store sales decline for the quarter of 3.9%, and the unfavorable impact of foreign currency fluctuations. BBY said traffic in 2Q increased “slightly” versus last year but was offset by a slight reduction in the average ticket price. The company added that same-store sales gains in notebook computers, mobile phones and flat-panel TVs were more than offset by decreases in gaming, digital cameras, music and movies. However, BBY did raise its full-year EPS outlook to $2.70-3.00, from $2.50-2.90, as the stabilization in customer traffic has caused it to become more confident in its outlook. Analysts are predicting $2.87, which is one penny less than the company earned last year.

Grocery chain Kroger Co. (KR $20) announced 2Q EPS of $0.39, short of the $0.44 estimate that analysts had anticipated, as revenues of $17.7 billion—including fuel sales—missed the Street’s forecast of $18.2 billion. Excluding fuel sales, total sales increased 3.5% versus the prior year, while same-store sales increased 2.6%. The company said shoppers are coming to its stores more often, but buying only as much as they need for the week or their next meal, and they show signs of running out of money by the end of the month. Management also said that margins were under pressure during the period as grocery stores competed for sales from struggling customers. "Sudden deflation in a highly competitive market can lead to retail prices and product costs that drop quickly, creating lower margins," the company said. Kroger reduced its full-year EPS guidance as well and shares were under solid pressure.

Citigroup Inc. (C $4) was down almost 10% after media reports that the US government may unload some of its 34% stake in the company. Bloomberg reported that the Treasury may start unloading shares as soon as October, and would aim to sell the holdings over the next six-to-eight months. Meanwhile, the Wall Street Journal reported that Citigroup executives are considering a sale of new and existing shares, in which the Treasury would unload an undetermined portion of its stake, and Citigroup would raise an additional $5 billion in new capital, citing unnamed people familiar with that matter. The Treasury’s 34% stake came after it invested $45 billion in the financial firm, receiving preferred shares in exchange for the capital. The government would stand to potentially earn billions of dollars in profit from the deal, as Citigroup shares have rallied approximately 40% since the government took a stake in the struggling bank. None of the entities involved has commented on the matter.

Illinois Tool Works (ITW $44) raised its 3Q EPS outlook from a range of $0.39-0.51, to $0.48-0.56, above the $0.47 that the Street is looking for. The industrial products and equipment firm said its revenue for the quarter is expected to increase between 3-6% compared to the $3.4 billion earned last quarter, based on improvements in discrete end markets such as automotive and construction. Analysts expect the company to report 3Q revenues of $3.5 billion. ITW was lower.

Capital One Financial (COF $37) reported that its annualized net charge-off rate—loans that it does not expect to be repaid—fell to 9.32% in August for US credit cards from 9.83% in July. But COF said its credit card delinquencies of at least 30 days—a gauge of future loan losses—increased from 4.83% to 5.09%. Shares were lower.

Elsewhere in the credit card industry, Bank of America (BAC $17 1) said its charge-off rate rose to 14.54% in August, from 13.81% in July. Citigroup saw its charge-offs increase to 12.14%, up from 10.03%. JPMorgan Chase (JPM $43) witnessed a jump from 7.92% to 8.73%, while American Express (AXP $35) was one of the few firms not suffering increasing losses, as its charge-off rate improved from 8.9% to 8.5%, although the company cautioned that the decline was “attributable in large part to the mechanics of the calculation,” as the company acquired Lending Trust last month, which skewed the data. Shares of BAC and JPM were lower today, while AXP finished higher.

Retail sales rise, wholesale prices jump, and manufacturing in New York improves again

Advance retail sales (chart) jumped 2.7% on a month-over-month (m/m) basis in August, well above the forecasted increase of 1.9%, representing the fastest pace in three years. On a year-over-year (y/y) basis, sales were still 5.3% below the level of August 2008. Although the majority of the strength in the report was due to the recent “cash-for-clunkers” program that offered consumers a cash incentive to trade in their vehicles, improvement was evident in core sales as well. Ex-autos, sales increased 1.1% m/m, versus the expected rise of 0.4%, while excluding autos, gasoline and building materials – the figure the government uses to calculate the consumer spending component of GDP – sales climbed 0.8% m/m, after a 0.3% decrease last month.

Looking into the various subcomponents of the index, sales at automobile dealerships and parts stores surged 10.6% during the month – the most in almost eight years – and almost all sectors showed signs of strength with the exception of furniture and building materials, which were the only two sectors showing a month-over-month decline. On a year-over-year basis, every sector except for food and health and personal care saw further declines.

Elsewhere, the Producer Price Index (chart) was announced this morning, showing a 1.7% month-over-month increase, much higher than the expectation that prices rose 0.8% in August. Most of the increase was explained by energy costs, which jumped 8.0% on a 23% increase in gasoline prices. Meanwhile, the core rate, which excludes food and energy, gained just 0.2%, versus the forecast of a 0.1% increase, showing that pricing pressures in the economy remain low. On a year-over-year basis, headline producer prices are now 4.3% lower, while the core rate is 2.3% higher.

The Empire Manufacturing Index, a measure of manufacturing in the New York region, rose in September to a level of 18.88, well above the level of zero that suggests conditions are neither contracting nor expanding. That was higher than the expected reading of 15.00, and the previous month’s 12.08 level. New orders increased from 13.43 in August to 19.84 in September but shipments declined from 14.11 to 5.34. The report is the first major piece of data looking at manufacturing conditions in September, and Thursday's Philly Fed Manufacturing Index, expected to improve from 4.2 in August to 8.0 in the current month, will compliment today's New York activity report, providing further insight into the health of the sector (economic calendar).

In other economic news, July business inventories (chart) fell 1.0%, slightly more than the forecast of a fall of 0.9%, and June was revised lower to a decline of 1.4% from the previously reported 1.1% fall. Sales increased a modest 0.1%, but the inventory-to-sales ratio—the amount of time it would take to deplete inventories at the current sales pace—still fell from 1.38 in June to 1.36 in July.

Also, Federal Reserve Chairman Ben Bernanke spoke at the Brookings Institute, delivering his “Reflections on a Year of Crisis” speech that was first performed at the Jackson Hole, Wyoming symposium on August 21. Bernanke, as expected, did not offer any new details about where the Fed stands in his speech, but he did say that the recession is now “very likely over,” although the pace of growth will be “moderate” and it may not feel like it’s over for many Americans. He added that the unemployment rate will come down “quite slowly” due to headwinds from ongoing credit problems and efforts by families to reduce household debt. With regards to the ongoing debate about whether additional government regulations will be passed for the financial sector, Bernanke stated “I feel quite confident that a comprehensive reform will be forthcoming."

Treasuries were lower following the busy economic agenda. The yield on the 2-year note rose 2 bps to 0.94%, the yield on the 10-year note added 3 bps to 3.45%, and the yield on the 30-year bond increased 4 bps to 4.27%.

More manufacturing and inflation data on the way

The Federal Reserve will release its industrial production data tomorrow, which is forecasted to show growth of 0.6% in August, following the 0.5% increase in July. The index shrank for 17 of the last 18 months prior to last month’s gain, and a second-straight increase could confirm that the industrial sector has finally found bottom. At the same time, economists expect the uptick in production will raise capacity utilization to 69.0%, which would be the second-consecutive month of improvement after the index touched a record low level of 68.1% in June.

Similar to the impact seen in this morning’s retail sales report, the government’s support of the auto sector has also influenced the manufacturing sector. Excluding motor vehicles and parts from last month’s data, manufacturing production edged up a slight 0.2% and even including the auto sector spike, industrial production last month was still 13.1% below the level of July 2008.

Another major inflation reading – the Consumer Price Index – will also be revealed tomorrow. It is expected that prices at the consumer level were up 0.3% in August, after being flat in July. When excluding food and energy, economists have forecasted that core consumer prices increased just 0.1% last month, inline with the prior period.